Vyom and Vansh catch up on a weekend and an interesting conversation follows:
Vyom: Last week, my news feed was buzzing with Reliance demerger and this week it is ITC hotels demerger. Why so much interest in these events?
Vansh: Isn’t it obvious? These are big conglomerates and widely-traded stocks. Such corporate actions are bound to impact shareholders and also the business landscape of the country.
Vyom: I get it, but why do these companies go for demergers?
Vansh: Demergers are not any random decisions but strategic ones. There are two prominent types of demerger methods — spin-off and split-up. The most common type of demerger is a spin-off demerger, here the parent company decides to carve out a particular division or subsidiary of the company as a new legal entity. The new company will have same assets, capital, intellectual property, and human resources. This is also sometimes called Horizontal demerger.
The company goes for this type of demerger when it wants to unlock value. In this type of demerger, the management of the company is of the opinion that the division or the subsidiary company will be more profitable when it is independent. It is also believed that such new company will have its own management specialised in the business, which will be better than the general management of the overall corporate. Here the shareholders of parent company are given shares of new company proportionately.
Vyom: Ok, what about share price, how is it affected and what about investors?
Vansh: The parent company stock price drops as the assets are now transferred to new company, thus reducing its book value . Ideally, the value of parent company stock along with the stock price of new company should be same or higher versus pre-spinoff stock price. The recent Reliance Industries and Jio Financial services demerger is an example of spinoff demerger.
Generally, it is good for investors; the demerged company, being the smaller one with focussed management, has good potential to grow and thus unlock value for investors.
Vyom: Cool! What about split-up then?
Vansh: Split-up or what is sometimes called a vertical demerger is where the parent company splits or hives of a business segment into a separate subsidiary and then transfers stake in that to external investors for a price or to its shareholders.. In this case the parent will retain some stake in the resultant company and balance shares are proportionately awarded to the shareholders of the parent company. The most recent example is the demerger of ITC hotels from parent, 40 per cent stake of ITC hotels will remain with ITC whereas 60 per cent will be distributed proportionately among the shareholders of ITC.